Rocky Mountain Farmers Union v. Corey: Ninth Circuit Holds that "California's Regulatory Experiment" Does Not Discriminate Against Out-of-State Ethanol and Crude Oil Producers

by King & Spalding

On September 18, 2013, the Ninth Circuit issued a ruling that may have significant consequences for oil and ethanol producers all across the globe. In Rocky Mountain Farmers Union v. Corey, No. 12-15131 (9th Cir. Sep. 18, 2013), the court vacated a lower court injunction against application of a California regulation that establishes caps on average carbon intensities of transportation fuels consumed in California. The regulation's "carbon intensity ratings" are based, in significant part, on calculations of emissions occurring during the production and transportation of the fuels entirely outside the State. The Ninth Circuit concluded that such regulation does not constitute extraterritorial regulation prohibited by the dormant Commerce Clause. Yet, it is difficult to see how California's regulation could not have a substantial impact on conduct occurring entirely outside its borders.

In response to a 2007 Executive Order issued by Governor Schwarzenegger directing the adoption of regulations that would reduce average greenhouse gas emissions attributable to California's fuel markets, the California Air Resources Board ("CARB") promulgated a regulation known as the Low Carbon Fuel Standard (the "Fuel Standard"). Compliance with the Fuel Standard is tied to a fuel blender's ability to keep the average carbon intensity of its total volume of fuel below an annual limit established by the Fuel Standard.

At the center of the parties' dispute in Rocky Mountain Farmers Union is the Fuel Standard's methodology for determining the carbon intensity of a given transportation fuel. The Fuel Standard applies a "lifecycle analysis," in which carbon intensity is determined by analysis of emissions associated with "all aspects of the production, refining, and transportation of a fuel, with the aim of reducing total, well-to-wheel GHG emissions." CARB then assigns a cumulative carbon intensity value to an individual fuel lifecycle, referred to as a "pathway," which defines whether a producer is at risk of exceeding its annual limit.

These elements of the regulation appear straightforward until one recognizes that the Fuel Standard employs a model that creates a specific geographical divide. With respect to production of ethanol (which California requires for fuel oxygenation), for example, the Fuel Standard, in a "Table 6," assigns average carbon intensities to producers in California, the midwestern United States, and Brazil (which uses sugar cane, rather than corn, for ethanol production). The factors used to determine these average carbon intensities include: (1) the growth and transportation of the feedstock; (2) the type of electricity used to power the plant; (3) the efficiency of production; (4) the milling process used; and (5) transportation of the fuel to the blender in California. Thus, it is not difficult to see that, with respect to non-California-based ethanol producers, the Fuel Standard is setting carbon intensity determinations, with attendant financial consequences under the regulation, based in large part on admitted extraterritorial conduct (i.e., GHG emissions occurring thousands of miles from California).

The Ninth Circuit concluded that the Fuel Standard is not discriminatory on its face against interstate commerce. Its citation to dormant Commerce Clause precedents, however, appears to have been a thin veil attempting to mask a result-based conclusion. The court assumes, without explanation, that emissions during the ethanol production and transportation processes in Brazil and in Iowa threaten California's "long coastlines vulnerable to rising waters, large population that needs food and water, sizable deserts that can expand with sustained increased heat, and vast forests that may become tinderboxes with too little rain" such that they should be included in a calculation of average actual impact to California. The court accepts at face value CARB's determination that emissions from the production and transportation of fuels thousands of miles from California "are caused by the in-state consumption of fuels," an argument that seemingly has the tail wagging the dog. And, the court expressly acknowledges that, with respect to crude oil production, the Fuel Standard assigns a significantly lower carbon intensity for certain California production and a higher carbon intensity for out-of-state production that represented nearly 60 percent of California's crude oil market in the year surveyed (2006), yet brushes aside any concern that the Fuel Standard may be violative of the dormant Commerce Clause by pointing to a portion of California crude oil sources that were negatively "caught in the crossfire" of the Fuel Standard's carbon intensity assignment.

At a fundamental level, the petroleum industry should be concerned by the court's admitted reluctance to interfere with a State's use of its regulatory system to "experiment" with measures that will have broad impacts outside its borders. Indeed, the court has embraced a scheme that has allowed a single State to "essentially assume[] legal and political responsibility for emissions of carbon resulting from the production and transport, regardless of location, of transportation fuels actually used in California." The court appears to have placed its imprimatur on a broad legal standard that would allow each of the 50 States to regulate all sorts of extraterritorial conduct on the basis that an end-product will be consumed within that State.

And, in fact, one panel member issued a dissent in which she calls out the majority for embracing CARB's supposed justifications for the Fuel Standard and carbon intensity formulas without making the threshold determination of whether the Fuel Standard is, in fact, discriminatory. The dissent calls special attention to Table 6 itself, which differentiates between in-state and out-of-state ethanol (something the majority acknowledges) and accords more preferential treatment to the former at the expense of the latter, much in the way the Fuel Standard assigns higher carbon intensity values to out-of-state crude oil production. This, according to the dissent, constitutes facial discrimination against interstate commerce that calls for application of a strict scrutiny standard.

And while the dissent believes CARB can satisfy the first prong of strict scrutiny – that the regulation serves a legitimate local purpose – it questions whether CARB can meet the second prong, which requires proof that the local purpose could not be served as well by available nondiscriminatory means. Indeed, the dissent points to the Fuel Standard itself, which allows, in certain circumstances, for regulated parties to use individualized pathways rather than the discriminatory average carbon intensity values set out in Table 6. As CARB has embraced the individualized pathway as an acceptable basis for reducing lifecycle GHG emissions, it must constitute a reasonable alternative to what is a facially discriminatory approach, notwithstanding that it might be more expensive or difficult to implement. As a matter of law, therefore, the dissent concludes that CARB cannot satisfy strict scrutiny.

A showdown in the United States Supreme Court appears likely. Whether the Court may re-examine its precedents on the dormant Commerce Clause and extraterritorial regulation is far from clear, but the Ninth's Circuit's statement that "California should be encouraged to continue and to expand its efforts to find a workable solution to lower carbon emissions, or to slow their rise," even when those efforts target out-of-state actors, demands additional judicial review.

 Jonathan L. Marsh
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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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